Splitting Payments Between Income and Principal
Asset-backed securities are investments whose value comes from pools of underlying financial assets, such as mortgages, auto loans, or credit card receivables. Each payment the trust receives from these securities contains a mix of interest (current return) and principal repayment. Arizona law requires the trustee to follow the payer's breakdown.
If a trust receives a payment from interest or other current return and from other proceeds of the collateral financial assets, the trustee shall allocate to income the portion of the payment that the payer identifies as being from interest or other current return and shall allocate the balance of the payment to principal.
A.R.S. § 14-7424(A)This approach keeps things straightforward. The trustee does not need to independently calculate what portion is interest versus principal. The payer's allocation controls. Income beneficiaries receive the interest component, and remainder beneficiaries are credited with the principal repayment.
Liquidating Payments and the Ten Percent Rule
Sometimes a trust receives payments that will eventually liquidate its entire position in an asset-backed security. If the full liquidation happens in a single accounting period, everything goes to principal. But if the liquidation stretches across multiple periods, Arizona applies a practical default: ten percent of each payment is allocated to income, and the remaining ninety percent goes to principal.
If a payment is one of a series of payments that will result in the liquidation of the trust's interest in the security over more than one accounting period, the trustee shall allocate ten per cent of the payment to income and the balance to principal.
A.R.S. § 14-7424(B)The ten percent rule provides a reasonable approximation. It acknowledges that even in a wind-down, the income beneficiary should receive some current return. At the same time, it preserves most of the payment for principal, reflecting the fact that the asset is being consumed rather than producing ongoing income.
